22

CHAPTER

Pricing, Costing,
and Growth
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:

Section 22.1
• Explain how to calculate selling
price.
• Identify variable and fixed costs.
• Discuss effective pricing.
Section 22.2
• Describe different forms of
business growth.
• Discuss profit planning.
• Explain how to calculate target
sales and margin of safety.
• Explain the importance of
planning for growth.

Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.

696
 In the Real World . . .
J anet Manzetti enjoys collecting unique pottery and dishware
and selling them at local fairs. The pieces are very popular, so she ap-
proached a local store about selling them. The store’s buyer was impressed by
the craftsmanship and offered to buy them for resale. Janet hesitated because her
costs of finding and paying for the goods are about what the store’s buyer wanted
to pay. However, she then thought about it and decided to improve the boxed
packaging. With fancy presentation, she could charge a higher wholesale price.
The store’s buyer agreed to pay more for the pottery, and Janet expanded her
business. The right pricing and costing allow Janet to make a profit.
As You Read Consider ways that any business owner
can use pricing to encourage sales.

Selling Price
ASK Q: I started making scarves and hats for my
friends for fun, but demand for them has become
so high that I am thinking of selling them. How much do I charge?
A: Your selling prices should be close to what your competitors charge. Make sure
that your business will be profitable at those prices. For many businesses, profit
margins are only in the 10 to 15 percent range. For each $1 in sales, the business
keeps ten cents—making accurate pricing essential.

Ask Yourself How do you find out what competitors charge?

Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.

finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 697

 Section 22.1

Focus on
Reading
Merchandise Pricing
and Costing
Read to Learn
• How to calculate selling
price. Pricing
• How to identify variable Why is pricing important to a business?
and fixed costs.
Pricing is the process of assigning a selling price to a good or
• How to discuss effective
pricing. service. Price is usually expressed in monetary terms, such as $60 for a
pair of shoes. It can also be expressed in non-monetary terms, such as
Main Idea free goods or services in exchange for the purchase of a product. The
Effective pricing and cost- oldest form of pricing is the barter system, which involves exchang-
ing are essential factors ing a good or service for another good or service without the use of
for a business’s financial money. For a merchandise business, you must price goods and services
success. appropriately for your business to succeed. If you set monetary prices
too high, customers may buy from your competition—or not buy at
Key Terms all. If you set prices too low, you may not be able to cover your costs
• pricing and operating expenses.
• product cost-plus pricing
• markup
• manufacturing business Goals of Pricing
• product costing
• cost behavior Many factors influence the prices of goods and services. Pricing
• variable costs decisions must take into account costs, competition, and economic
• direct materials conditions. To make sound pricing decisions, a business owner must
• direct labor consider the goals of pricing.
• fixed costs
Every business owner wants to set effective prices that yield large
• contribution margin
• break-even point profits. Most businesses have three goals that act as guidelines for
effective pricing:
• To obtain a given share of the market
• To generate sales that produce a specific profit
Before
• To meet competitors’ prices
You Read
In establishing prices, a business may have to prioritize these
PREDICT
three goals. For example, suppose that a primary goal of your new
What factors do you think outdoor sportswear business is to match your competitors’ prices. You
a retailer should consider must remember that if you set your prices too low, you may not gener-
when setting prices for
ate enough profit for your business to succeed. Suppose that the pri-
merchandise?
mary goal of your business is to increase profits. You can achieve your
objective by selling more items at the current price or by selling the
same number of items at a higher price. However, if you raise prices to
increase profits, you may no longer meet competitors’ prices. You must
decide which pricing goals are most important to your business.

698 Unit 6 Business Finance Basics

Merchandise Pricing
How do retail businesses price merchandise they sell?
All the financial procedures you have learned so far have involved
merchandising businesses. A merchandising business buys goods,
marks them up, and sells them to customers, such as retail stores.
Establishing selling prices in this type of business is relatively simple.

Retail Pricing Methods

A retail business sells goods or services to the final user, the con-
sumer. One pricing method commonly used by retail businesses is
product cost-plus pricing. Product cost-plus pricing is the pro-
cess of determining an item’s selling price by adding the invoice cost
of the item (how much the business paid for the item) to a certain
percentage of that cost. This added amount is the markup, which
is the difference between the cost of an item to a business and the
selling price of the item. This markup amount must cover all of the
business’s expenses and allow for a profit.
For example, Luggage World is a retail store that sells a wide vari-
ety of travel bags and suitcases. As merchandise is received, the store
manager prices all bags with a 70 percent markup. Suppose that the
Presidential Bag has an invoice cost of $48. The manager calculates
the selling price as follows:
Purchase cost $48.00
Plus markup ⫹ 33.60 ($48.00 ⫻ .70 or 70%)
Selling price $81.60

䊴 ANNOUNCING PRICES
Newspaper and magazine
advertisements are sources
for information on what
competitors are charging
for goods. Do you think
a business should always
match competitors’ selling
prices? Why?

Chapter 22 Pricing, Costing, and Growth 699

As You
Read
RELATE
Think about sales where
you have “gotten a bar-
gain.” What do you think
the retailer reduces to
come up with a sale price?
Adjusting Prices
If you cannot sell an item or a line of merchandise with a partic-
ular markup, you may have to lower the selling price or discontinue
stocking the item. The decision to mark up items by a certain percent-
age will depend on factors such as economic conditions, competi-
tion, or the season of the year.
Suppose that you purchase sweatshirts for your outdoor sports-
wear shop at $12 per shirt and price each one with a markup of 60
percent ($12 ⫻ .60 or 60% ⫽ $7.20). The retail price of each sweat-
shirt is $19.20 ($12 ⫹ $7.20 ⫽ $19.20). However, if your competitors
are selling the same sweatshirts for $17.99 each, you will probably
have difficulty selling your sweatshirts with a 60 percent markup. If
you lower your price to be competitive, you may not earn enough
profit to cover your expenses. If you cannot purchase the same sweat-
shirts from another supplier at a lower cost, you may have to sell a
different line of sweatshirts.
The percentage of markup will vary depending on the line of
merchandise you are selling. Stores (such as jewelry stores) that sell
very few items in a day have higher markup percentages than stores
(such as music stores) that sell many items in a day. Regardless of the
product, the markup must cover expenses and generate a profit for
the business.

䊱 EXPENSIVE ITEMS A jewelry store may have only a few potential cus-
tomers each day and will sell merchandise to only a small percentage of
them. Why does a jewelry store have to set high prices on its merchandise?

700 Unit 6 Business Finance Basics

Costing and Pricing in a
Manufacturing Business
How does costing affect pricing for
manufacturing businesses?
Not all businesses simply purchase items, mark them up,
and resell them to customers. Some businesses produce new mer-
chandise. These businesses are called manufacturing businesses. A
manufacturing business is a business that buys raw materials or
processed goods and transforms them into finished products.
For example, if Tonya decides to sell hand-decorated hand-
bags to her friends, her business will be a manufacturing business.
She purchased a plain bag and decorated it, using paints, buttons,
and sewing materials to create a desirable new item. Tonya will
have to consider the cost of the materials and labor that go into
the production of her first bag before she can determine an appro-
priate price for similar bags. Determining costs and pricing in a
manufacturing business is more complicated than it is in a retail
business.

Careers in Finance
CREDIT ANALYST
CHIEF FINANCIAL Alberto Saenz
OFFICER Cycle Gear
Alberto loves to make short-term goals that help achieve long-term ones. As the chief financial
officer (CFO) for a chain of motorcycle parts, accessories, and clothing retailers, Alberto is expected
to direct the company’s overall financial policies, procedures, and reporting that are required to con-
tinue a 30 percent per year growth rate with increasing profitability. He manages all financial func-
tions, including accounting, budgeting, cash flow, bank relationships, risk, inventory management,
and taxes. Besides knowledge of accounting, CFOs need to know federal and state laws and regula-
tions as well as international trade.
SKILLS: Accounting, analytical, communication, computer, decision making, math,
problem solving, and long-range planning skills
PERSONAL TRAITS: Able to see the big picture, able to cope with stress, flexible, good judgment,
independent, likes working with people and numbers, and tactful
EDUCATION: High school diploma or equivalent; bachelor’s degree or master’s degree in
accounting, economics, finance, or business administration; Certified Public
Accountant certification
ANALYZE Why would a CFO need to understand pricing principles?

To learn more about career paths for chief financial officers, visit
finance07.glencoe.com.

finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 701

 Product Costing
Product costing is the process of analyzing all costs involved
in creating products. By product costing, you can establish a selling
price that is both competitive and profitable for your business.
Product costing will help Tonya decide whether she can sell hand-
decorated bags for a reasonable price. Her costs for the first bag might
be low. Thus, she could make and sell similar bags at a profit. However,
making the first bag could be expensive. To cover costs, she would have
to set a high price. The price may be so high that no one would buy the
bags. Thus, Tonya could decide that the bags are not worth making.

Global Financial Landscape

Standard and Poor’s publishes the globally recognized

S&P 500® financial index. It also gathers financial statis-
(ANOI
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.

VIETNAM
The Vietnamese have a saying: “Close the past,
open the future.” When American troops pulled out of
Vietnam at war’s end in 1975, they were the enemy.
Today they are welcomed as friends. The Vietnamese DATABYTES
have opened up former war-related sites as part of The
Vets’ Tour, adding one more market to their soaring Capital Hanoi
economy. In the last decade, the country’s economy Population 80,786,000
has grown 7.4 percent a year. Two of the most famous
Languages Vietnamese, English, French, Chinese,
exhibits include the “Hanoi Hilton,” a war prison, and
Khmer, and local languages
the Cu Chi tunnels. This underground, 75-mile-long
maze hid thousands of guerilla soldiers. Now widened Currency dong
to accommodate tourists, the tunnels display mess Gross Domestic
halls, meeting rooms, Product (GDP) $203.9 billion (2003 est.)
and a small cinema. GDP per capita $2,500
Tourism is a growth Industry: Food processing, garments, shoes, and
industry in Vietnam. machine manufacturing
Many hotels have been Agriculture: Paddy rice, corn, potatoes, rubber, poultry,
rated at three to four and fish
stars, and investors such
Exports: Oil, marine products, rice, coffee, and rubber
as Disney are develop-
ing resorts. Focusing on Natural Resources: Phosphates, coal, manganese,
cultural, ecological, and bauxite, and chromate
business tourism, Viet-
nam may attract 7.5 mil- Think Globally
lion visitors by 2010. How might pricing and costing affect Vietnam’s tourist
industry?

702 Unit 6 Business Finance Basics

 䊴 THEY’RE HOT! Items
that are in great demand,
such as barbecues during
warm weather, rarely go
on sale during the summer
months. What might be the
reason for this?

Classifying Costs
What are the different types of costs to consider?
Whether you are the manager of a large business, such as Gen-
eral Electric, or a small business, such as a local bakery, you need com-
plete information about costs to make smart financial decisions. You
must identify your costs and determine what costs will increase, and
what costs will remain the same.
Cost behavior is the way a cost changes in relation to a change
in business activity. For example, as your business makes more items, Common
some costs may increase, such as the costs of additional materials
or labor. Other costs remain constant and are not influenced by the CENTS
number of items you produce or the volume of sales. These costs
could include rent, taxes, and insurance. In analyzing cost behavior, Business Expenses
When planning for
you will usually classify costs as variable or fixed.
expenses that will affect
the prices of the products
Variable Costs you sell, consider your
operating expenses. The
In product costing, variable costs are costs that change in top ten small business
direct proportion to the activity level of production. This means expenses include: health
that if production increases, these costs will increase. If production insurance, DSL or dial-up
Internet fees, cell phone
decreases, your variable costs will decrease.
fees, utilities, advertising,
To understand cost behavior, consider the example of Windy accounting services, voice
River Creations. Wayne and Naomi are Native Americans who want mail, financial planning
to start a small business producing handmade Native American jew- services, and collection
elry. They intend to buy metal bands, beads, leather, and other mate- services. Choose a small
rials and make items to sell to area stores. They have rented a small business that you would like
to own. If you were looking
shop, purchased a few pieces of equipment, bought materials and
for ways to cut back on your
supplies, and hired two local artists to make the jewelry. business expenses, what
Windy River has identified three variable costs. These are areas would you target
(1) direct materials used to make the jewelry, (2) direct labor to create and why?
the jewelry, and (3) supplies used in processing the jewelry.

Chapter 22 Pricing, Costing, and Growth 703


MATH
Imagine you have a retail
business selling widgets,
doodads, and thingama-
bobs. You want to deter-
mine the selling price for
each. You have costs, such
as rent and labor plus the
items’ wholesale costs.
Figure the markup at 70%
and the price for each item:
Item Costs
Widgets $1.32
Doodads $4.80
Thingamabobs $8.74
Direct Variable Costs Direct materials are the raw materials
used to make a finished product. For Windy River’s jewelry, these
materials include metal, beads, leather, pins, packaging, and other
items. Wayne and Naomi plan to produce five pieces of jewelry, one of
which is the Sunset Bracelet. The direct materials needed to produce
each bracelet cost $4.30.
Direct labor is the work required to convert raw materials into
a finished product. To determine the cost of direct labor, multiply
the amount of time spent to produce the item by the employee’s
hourly wage. Wayne and Naomi are paying their employees $12 per
hour. It takes approximately 15 minutes (0.25 hours) to make the
Sunset Bracelet. Therefore, the cost of direct labor per bracelet is
$3 (0.25 ⫻ $12 ⫽ $3).
Wayne and Naomi now know that the cost of materials and
labor needed to make the bracelet is $7.30 ($4.30 direct materials
plus $3 direct labor). They must also take into account the cost of the
supplies that will be consumed in the production process. This cost
could include polish, wire, solder, glue, and finishing spray. Wayne
and Naomi estimate that the cost of the supplies for one bracelet is
$0.35. This brings the total variable cost per bracelet to $7.65, illus-
trated as follows:
Direct materials $4.30
Direct labor 3.00
Supplies 0.35
Total variable cost $7.65

As more units are made, the variable cost assigned to each unit
remains the same, but the total variable cost for the business increases.
When fewer units are made, total variable costs decrease. The table
below shows how the total variable cost for Windy River increases or
decreases depending on the number of Sunset Bracelets made.
Unit Total
Variable Cost Variable Cost
7 Bracelets $7.65 ⫻ 7 ⫽ $53.55
10 Bracelets $7.65 ⫻ 10 ⫽ $76.50
18 Bracelets $7.65 ⫻ 18 ⫽ $137.70

Fixed Costs
Rent, insurance, taxes, salaries, and some utilities are examples
of fixed costs. Fixed costs are costs that remain constant even if
activity or production level changes. The total fixed cost remains the
same regardless of the number of units produced.
For example, Wayne and Naomi pay $700 per month to rent the
shop that Windy River occupies. Regardless of the number of brace-
lets produced in a month, the fixed cost of rent will remain at $700.
Remember, the selling price of the bracelets must exceed all fixed costs
plus all variable costs in order for Windy River to make a profit.

704 Unit 6 Business Finance Basics

 䊴 LABOR INTENSE Many
manufacturing companies
use robots to assemble prod-
ucts. What are some advan-
tages of using robots instead of
human beings?

Selling Price
How do businesses determine the selling price for goods?
Wayne and Naomi plan to mark up the variable costs by approxi-
mately 70 percent in order to cover the fixed costs and show a profit.
The total monthly fixed costs for the business are $1,400. Windy River is
selling five types of jewelry, so each type must cover one-fifth, or 20 per-
cent, of the fixed costs per month. Therefore, each type of jewelry must
cover $280 in fixed costs per month ($1,400 ⫻ .20 or 20% ⫽ $280).
If the variable costs total $7.65 for each bracelet and a 70 percent
markup is added, the selling price of the bracelet will be $13 ($7.65 ⫹
[$7.65 ⫻ .70 or 70%] ⫽ $13). Wayne and Naomi must determine whether
this markup is sufficient. To do so, they will have to figure out how
many bracelets they must sell to cover both fixed and variable costs.

The Contribution Margin

What is the contribution margin?
The contribution margin is the amount of money that the
Franchise Ownership
sale of a particular product contributes toward the payment of fixed
What skills and abilities
costs and the profit of a business. The contribution margin equals make a business leader
total sales minus total variable costs. For example, if a product has effective? Learn more
sales of $13,000 and has variable costs totaling $7,000, it has a contri- about leadership and
bution margin of $6,000. This is the product’s contribution to cover imagine yourself as a
the fixed expenses and provide a profit. great business leader.

Sales $13,000 To continue with

Task 5 of your
Minus variable costs ⫺ 7,000
WebQuest project, visit
Contribution margin $ 6,000 (Amount available finance07.glencoe.com.
for fixed expenses)

finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 705

 Learn to identify and understand the standard
financial documents you will use in the real world.

Investigate: A Break-Even Analysis Your Motive: If you manage or own

A break-even analysis contains the
following information:
• Names of the products analyzed
• Unit pricing and fixed and variable
expenses
• Calculation for number items that must
be sold to break even
a retail store, you need to analyze your
merchandise pricing, costs, and sales to
determine when you are making a profit.
The Break-Even Analysis Worksheet can
help you determine profitability.

"REAK %VEN!NALYSIS7ORKSHEET

3TORE 3ALLIES!CCESSORIES
,OCATION &ASHION7AY
3KOKIE)LLINOIS
0RODUCT,INE *EWELRY
0ERIOD 3IXMONTHSBEGINNING*UNE

)TEM 5NIT0RICE0 6ARIABLE#OSTS &IXED#OSTS& 5NITSTO

PER5NIT6 "REAKEVENN
0N6N&
7ATCHES    
.ECKLACES    
2INGS   
"RACELETS    
%ARRINGS    

Key Points: Fixed costs can include Find the Solutions

such expenses as rent, utilities, insurance,
advertising, and administrative expenses.
1. What are the total fixed costs assigned to
the jewelry department for the six-month
period?
2. What is the break-even point for necklaces?
3. Which item has the highest markup?
4. What would happen to the break-even point
if Sallie raised the price of the bracelets?
5. How much does a ring cost at Sallie’s?

706 Unit 6 Business Finance Basics

The Break-Even Point
Why do businesses that sell products want to know
the break-even point?
TechByte
Pricing Science When
The break-even point is the point at which total sales equal setting the price for a
total costs (variable and fixed costs). The break-even point represents product, some businesses
use product cost-plus
the sales that a business must achieve to break even, or cover all costs.
pricing; some consider
At the break-even point, there is neither a profit nor a loss. how the competition is
Calculating the break-even point helps a business owner predict priced; and some look
how changes in costs and sales will affect the profit earned by the at the break-even point.
business. The break-even analysis can also determine how many units A variety of e-newslet-
of a product must be made and sold to cover expenses. ters provide information
covering case studies,
For example, suppose that you wanted to calculate how many
marketing trends, and
units of the Sunset Bracelet that Wayne and Naomi would have to the latest product news
sell to break even, or cover all costs. Represent the number of units on pricing strategy. This
needed to break even by a variable such as n. On the left side of the research can help busi-
equation, multiply unit sales price by n. On the right side of the equa- nesses determine the
tion, multiply the unit variable costs by n, then add the total fixed best price for a product.
costs. Solve for n. Learn more about
Break-even sales are the sales, expressed as a dollar amount that pricing science
a business must make to cover all costs. Break-even sales for the Sun- and research and list
set Bracelet are $689 (53 bracelets ⫻ $13 ⫽ $689) per month. The fol- resources through
finance07.glencoe.com.
lowing calculations show the accuracy of the math.

GO FIGURE FINANCIAL MATH

BREAK-EVEN POINT Solution:

$13.00n ⫽ $7.65n ⫹ $280.00
Synopsis: By calculating the unit variable cost of
$13.00n ⫺ $7.65n ⫽ $280.00
products to sell with the monthly fixed costs, a busi-
$5.35n ⫽ $280.00
ness can figure out how many units of a product
n ⫽ $280.00 ⫼ $5.35
must sell to break even.
n ⫽ 52.3 or 53 bracelets
Example: Windy River sells each Sunset Bracelet
To break even, Windy River must sell 53 Sunset
for $13. The unit variable cost for the bracelet is
Bracelets each month.
$7.65. The amount of monthly fixed costs that sales
of the Sunset Bracelet are expected to contribute is
$280. How many units of the Sunset Bracelet must YOU FIGURE
Windy River sell to break even? Your sister is selling custom printed T-shirts at
Formula: the beach on weekends. Fixed costs from sales
Break-Even Sales ⫽ Variable Costs + Total Fixed Costs total $345. How many bracelets should she sell
Unit Sales Price ⫻ n ⫽ (Unit Variable Costs ⫻ n) to break even if each T-shirt sells for $20 and the
⫹ Fixed Costs unit variable cost is $11.50 each?

finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 707

 Total Unit
As You
Read Sales (53 ⫻ $13) $689.00 $13.00
Less variable costs (53 ⫻ $7.65) ⫺ $405.45 ⫺ $7.65
QUESTION Contribution margin $283.55 $ 5.35
Define, in your own words, Less fixed costs ⫺ $280.00
fixed costs, variable costs, Net income $ 3.55
and break-even point.
Fortunately for Wayne and Naomi, Windy River has been aver-
aging sales of 70–80 bracelets per month for the past few months,
exceeding their break-even point. At the present rate of sales, the
bracelet’s contribution margin is covering its share of fixed costs and
is contributing to a net income for the business.
By substituting different numbers in the break-even equation,
Wayne and Naomi can analyze how changes in sales price, costs, and
sales volume affect profit. What if only 45 bracelets are sold? What if
the variable costs increase by $2? How much profit is reported if 75
bracelets are sold? Such questions are an important part of financial
analysis. If you are a business owner, you must anticipate changes in
the market and be prepared with alternative plans if the changes actu-
ally occur. Using the techniques to analyze all financial possibilities
and being prepared for change can help keep a business growing.

Section 22.1 Assessment

QUICK CHECK
1. What are the basic goals that businesses use
for setting prices?
2. What is the difference between variable
costs and fixed costs in product costing?
3. What is the purpose of calculating the
SOLVE MONEY PROBLEMS
break-even point?
6. Establishing Retail Prices Cookie
THINK CRITICALLY
4. Describe what might happen if a retail
business sold its products to consumers for
the same price it paid for them.
USE MATH SKILLS
5. Break-Even Point Dani sells mirrors
at weekend craft shows for $75 each. She
makes the mirror frames out of colored
pieces of glass and ceramic tile. The mirrors
are very popular, and Dani has more orders
than she can fill.
Calculate Help Dani figure out
how many mirrors she has to sell to
break even. Dani estimates that her vari-
able costs are $25 per mirror and her fixed
costs are $1,000.
Cutters is a retail store that sells a variety
of kitchen gadgets and gifts. Today is your
first day on the job there, and you have
been asked to price the food processors that
have just arrived. The manager has told
you that all products have a 65 percent
markup. The invoice price of one food pro-
cessor is $72.
Calculate Figure out the selling
price of each food processor.

708 Unit 6 Business Finance Basics

 Section 22.2

Planning for Growth Focus on

Reading

Sources of Business Growth Read to Learn

What are the different sources of business growth?
• How to describe differ-
The key to all successful business operations is growth. Businesses, ent forms of business
whether they are small sole proprietorships or large corporations, are growth.
much like people. They must grow and mature to achieve success. A • How to discuss profit
planning.
business that does not grow can end up far behind its competition.
Business growth can come from many sources and can be mea- • How to calculate
target sales and
sured in many ways. It may develop from an increase in the number
margin of safety.
of customers, sales, share of the market, employees, lines of merchan-
• How to explain the
dise, and (of course) profit. These are important aspects of growth for importance of planning
any business as well as indicators of success. However, growth should for growth.
be carefully planned and directed. Sound financial planning is essen-
tial for making decisions regarding expansion. Main Idea
Not every aspect of your business needs to grow every year. For a To be successful, a business
business, bigger does not necessarily mean better. If a business grows too needs to make a profit but
rapidly or in the wrong area, serious financial problems may result. also must grow.
Planning growth to correspond with the business’s short-term
and long-term goals is essential to financial success. If you have a Key Terms
business, short-term goals for the business reflect the areas to con- • target profit
centrate efforts. One year you may place an emphasis on increasing • target sales
• margin of safety
the number of customers; the following year, you may explore new
lines of merchandise. As one of your target areas grows, others may
also increase and grow. For example, if you concentrate on increasing
your number of customers this year, your sales and profits should also
report increases. Primary growth in one area often leads to secondary
Before
growth in other areas.
You Read
PREDICT
Customers In what ways do you think
Adding new customers usually causes a rise in sales. More sales businesses can grow?
usually result in greater profits. Increasing the number of customers is
always a primary goal in business. Acquiring new customers is often a
result of two factors: effective advertising and promotions and refer-
rals by satisfied customers. Potential customers must know where the
business is located, and they must believe that buying goods and ser-
vices from your business will be a positive experience. Although you
may have control over your advertising and marketing programs, you
have little or no control over customer referrals. Satisfying your cus-
tomers’ needs is the key to building a solid customer base.

Chapter 22 Pricing, Costing, and Growth 709


Avoiding Fees
1. Shop around for
business checking
accounts with low
or no fees.
2. Pay your credit
card and other
bills in full each
month on time.
3. Use a free Internet
service.
4. Ask your telephone
company for the
best small business
deal.
5. Return all equip-
ment rentals on
time to avoid late
fees.
As You
Read
RELATE
Can you think of a com-
pany that began offering
more types of products
than it had in the past?
710 Unit 6 Business Finance Basics
Sales
Growth in sales is also a source of business growth. When sales
increase, however, you must be capable of handling the larger vol-
ume so that you continue to satisfy your customers. If sales grow too
quickly, and you do not have enough employees, the quality of your
customer service may suffer seriously. In addition, you must be sure
that you have sufficient merchandise to offer.
Market Share
A measurement of growth is the business’s share of the exist-
ing market. If your business held approximately 15 percent of the
potential market last year, and this year your market share has risen
to 19 percent, you have achieved positive growth. This is evidence
that your business is staying competitive, probably through effective
advertising and promotions.
Market Development
A business can grow and expand its products to reach new loca-
tions locally, nationally, or even internationally. Franchising is one way
to grow. Franchisers sell the right to operate a business under the com-
pany’s name. In exchange for a fee, you the franchiser provide training,
hiring, and other assistance such as manuals and market analyses.
Employees
As your market share grows and your sales increase, you must
maintain an appropriate number of employees to contribute to
growth. The need to hire more employees to accommodate your cus-
tomers is a sign of positive growth. However, the additional employ-
ees should be utilized in the proper manner. Payroll is a major expense
of your business.
Product Development
When expanding with a new line of merchandise, carefully
analyze the potential market and estimate the profits to be made.
Expanding for the sake of expansion is not always a source of posi-
tive growth. The new line should assure a new sales market and good
profits. Unfortunately, many small businesses experience financial
success only to expand to new areas that prove unprofitable.
Profits
One of the key indicators of the success of your business is the
rate of growth of your profits. Making a profit is crucial to your busi-
ness. Profits must grow for your business to survive. However, plan-
ning for increased profits is often easier said than done. Businesses
may approach profit in several ways.
 䊴 HOW MANY CAN YOU
SELL? Stores are always
faced with the problem
of realistically predicting
how many items can be
sold. What problem could
result from stocking too many
soccer balls?

Profit Planning
How can a business plan to make profits?
Business managers frequently evaluate cost and profit data to
determine how to maximize profits. They use break-even analysis
to test possible changes and to determine how those changes might
affect future profits. Using the results of their analysis, managers fore-
cast sales and plan financial activities for their business.

Setting a Target Profit

An important part of the planning process is setting goals. One
common goal is to increase the amount of net income, or profit.
Target profit is the amount of net income that a business sets as a
goal. For example, you may want to expand to a new line of merchan-
dise or possibly open another outlet or store. In order to fulfill these
objectives, you will need to generate a given amount of profit.
Suppose that Wayne and Naomi want to earn a profit of $500 As You
per month over the next six months on sales of the Sunset Bracelet. Read
Assuming that the selling price and costs remain constant, how many QUESTION
bracelets would they need to sell to achieve this target profit?
Target sales is the number of units a business needs to sell to What is the difference
reach a target profit. The target sales equation is as follows: between target profit and
target sales?
Target Sales ⫽ Variable Costs ⫹ Fixed Costs ⫹ Target Profit

Chapter 22 Pricing, Costing, and Growth 711

 GO FIGURE FINANCIAL MATH

TARGET SALES Solution:

$13.00n ⫽ $7.65n ⫹ $280.00 ⫹ $500.00
Synopsis: Calculating how much product a busi-
$13.00n – $7.65n ⫹ $280.00 ⫹ $500.00
ness must sell to reach a profit is essential for success.
$5.35n ⫽ $780.00
Example: Windy River sells each Sunset Bracelet n ⫽ $780.00 ⫼ $5.35
for $13. The unit variable cost for the bracelet is n ⫽ 145.7, or 146 bracelets
$7.65. The amount of monthly fixed costs that sales
Windy River would have to sell 146 Sunset Bracelets
of the Sunset Bracelet are expected to contribute
to achieve its target profit.
is $280. The target profit is $500 per month. How
many units of the Sunset Bracelet must Windy River
sell to reach its target profit? YOU FIGURE
Formula: You are selling smoothies at school-sponsored
Target Sales ⫽ Variable Costs ⫹ Fixed Costs ⫹ sporting events. You price them at $3.50 each.
Target Profit The unit variable cost is $1.25 each. Your
Unit Sales Price ⫻ n ⫽ (Unit Variable Costs ⫻ n) ⫹ monthly fixed costs by sales should be $150.
Fixed Costs ⫹ Target Profit The target profit is $400 a month. How many
smoothies should you sell?

Using the target sales equation, you can calculate how many
units a business must sell to reach its target profit. Represent the num-
ber of units needed to achieve the target profit by a variable such as n.
On the left side of the equation, multiply the unit sales price by n. On
the right side of the equation, multiply the unit variable costs by n.
Then add fixed costs and the required profit. Solve for n.
Windy River has been selling about 70 to 80 bracelets per month,
and sales have risen approximately 10 percent per month. By increas-
ing current sales by approximately 10 percent a month for the next six
months, Windy River will sell about 124 Sunset Bracelets per month
by the sixth month. Assuming current sales are 70 per month, pro-
jected sales would be as follows:*
Month 1 77
2 85
3 94
4 103
5 113
6 124
(*Assumes 10 percent increase in current sales per month.)

Windy River would have to sell 146 bracelets per month to reach
its target profit of $500. Wayne and Naomi decide that this is an
unrealistic expectation. They conclude that a target profit of $400 is
more realistic. Using the target sales calculation, they determine that
they must sell 128 bracelets each month to achieve the goal of $400
profit per month.

712 Unit 6 Business Finance Basics

Margin of Safety Put on
When you are analyzing target sales and profits, you should con- Your
sider what will happen if you do not reach your target. Your margin of Financial
safety will indicate the amount that sales can drop before the business
Planner’s
experiences a loss. The margin of safety is the target sales minus
the break-even sales, which indicates the amount of risk that sales will Cap
meet the break-even point. A high margin of safety suggests a minimal Imagine you are operating
risk that sales will fall below the break-even point. Wayne and Naomi an athletic shoe store for
calculate the margin of safety for the Sunset Bracelet as follows: teens. You plan to expand
your merchandise lines. You
Target sales $1,664.00 128 bracelets can (a) sell shoes to other age
(to achieve a profit of $400) groups, or b) sell other items
Less break-even sales ⫺ 689.00 ⫺ 53 bracelets to the teen market. Which
expansion plan will you fol-
Margin of safety $975.00 75 bracelets
low and why?

The margin of safety is $975, or 75 bracelets. This means that

sales can drop by this amount below target sales before the business
experiences a loss on this item. For Windy River, this target sales
amount is a fairly safe venture.

䊲 SHORT DEMAND Items such as seasonal clothes and CDs have a

short selling period. Tastes in music and clothes change, and new items
come out every day. Can you name any other products that have a very
short selling period?

Chapter 22 Pricing, Costing, and Growth 713

 䊱 CONTROLLED EXPANSION Expanding a small business such as a
restaurant or boutique is good, but you should not expand too rapidly.
Can you name a business in your area that expanded but then had financial
problems?

The Challenges of Growth

What are the factors that might affect a business’s
ability to grow?
If your business is successful, it will probably grow. If you have
planned effectively for growth, you will also experience growth. How-
ever, you should consider whether your business is ready or suited for
growth. Several factors affect the ability of a business to grow:
• Market characteristics—If your niche market is too small,
your business may be unable to grow. To develop further, the
business must expand outside into new market areas.
• Multiple sites—With more than one location, you must
decide where your main operations will be located. You will
also need to staff your other locations.
• Delegation—Many small business owners are successful at
starting their own businesses. However, they may not have
the skills to manage others to do expanded tasks. You might
consider hiring someone as a manager.
• Industry innovation—If your industry’s growth is
dependent upon innovation or constantly changing ideas and
products, you will have to move ahead faster than the trends.
• Systems and controls—Effective systems and controls need
to be in place for management, marketing, finances, and record
keeping.

714 Unit 6 Business Finance Basics

Planning and Growth After You
Why is planning so important? Read
As you project your business’s financial prospects, you must ana- REACT
lyze carefully where you will spend your profits. Growth is important,
How can profits be used?
but only if it is carefully analyzed, planned, and controlled. Good
planning will usually result in successful growth; poor planning could
drive you out of business.
The following guidelines will not guarantee successful decisions,
but ignoring them could result in business failure:
• Make sound financial decisions when setting short-term and
long-term goals.
• Set realistic financial targets.
• Control expenses and costs.
• Analyze financial statements frequently.
• Analyze your competition.
• Evaluate current economic conditions.
• Maintain a reserve fund.
You may always have limited funds to invest for business growth.
However, careful planning and financial analysis should provide you
with the knowledge you will need for intelligent investment deci-
sions and well-planned, controlled growth of your business.

Section 22.2 Assessment

QUICK CHECK
1. What are the common forms of business
growth?
2. How is the target sales figure calculated?
3. How is margin of safety calculated?
Write About It You write an
advice column for small business
owners. What guidance might you give
Lil regarding the goals she has set for The
Rug Rack?

THINK CRITICALLY SOLVE MONEY PROBLEMS

4. Explain why business growth just for the
sake of growth is not wise.
USE COMMUNICATION SKILLS
5. Business Growth Lil owns an indepen-
dent rug store in a small town. The Rug
Rack has been open for about a year, and
business has been very good. Currently she
sells new and antique rugs as well as home
decorating magazines. Lil thinks that it is
time to add a new line of merchandise and
expand her customer base.
6. Achieve Target Profit You have been
hired by Windy River Creations as a business
consultant. After analyzing the market for
the company’s products, you determine it is
possible to earn a profit of $600 per month
within the next six months on the Sunset
Bracelet. Assume that the bracelet will con-
tinue to sell for $13 and that the costs will
remain constant.
Calculate Figure out how many
bracelets Windy River will need to
sell in order to achieve this target profit.

Chapter 22 Pricing, Costing, and Growth 715

 Chapter 22 Review & Activities

CHAPTER SUMMARY

• In merchandising businesses, product • Businesses grow by increasing cus-

cost-plus pricing is used: A markup
based on the cost of the item is added to
the actual cost. The markup percentage
covers business expenses plus profit
margin. In manufacturing businesses,
product costing covers raw materials,
plus the cost of processing them into
finished products, plus profit.
• Variable costs, such as direct materials
and direct labor, change in proportion
to production levels. Fixed costs remain
constant despite production level
changes.
• By determining the contribution margin
and break-even point, a business can set
attractive prices that also ensure a profit
for the business.
tomers, sales, market share, markets,
number of employees, lines of
merchandise, and profits.
• Profit planning occurs by setting target
profit goals and estimating a margin of
safety—target sales minus break-even
sales.
• Target sales needed to reach a target
profit is equal to variable costs, plus
fixed costs, plus target profits. The
margin of safety is the amount that
sales can drop before the business
experiences a loss. This is equal to the
target sales minus the break-even sales.
• Planning for growth will enable you
to grow in a controlled way and to be
prepared and able to take advantage of
growth opportunities when they appear.

Communicating Key Terms

Imagine you are a consultant assisting the owner of a florist shop in pricing her flowers and
floral design services. Use as many of the key terms as you can to write a presentation on pricing.
• pricing • cost behavior • contribution margin
• product cost-plus pricing • variable costs • break-even point
• markup • direct materials • target profit
• manufacturing business • direct labor • target sales
• product costing • fixed costs • margin of safety

Reviewing Key Concepts

1. Explain why product cost-plus pricing would not work in a manufacturing business.
2. Explain why, in some cases, it may be beneficial to have more variable costs and to also
reduce fixed costs.
3. Explain why the contribution margin is so important.
4. Explain why expanding into new lines of merchandise may not lead to business growth.
5. Explain why determining target profits is necessary to plan for business growth.
6. Explain why the margin of safety is so important to a business.
7. Discuss how your reserve fund can affect growth opportunities.

716 Unit 6 Business Finance Basics

 Chapter 22 Review & Activities

Economics Clothing is often marked up more than 100 percent.

Write About It Write a paragraph explaining what this means in terms
of the price you pay in the store. Include your analysis of factors that go into
the price determination, other than the cost of the clothing before markup.

Margin of Safety Target sales for Cricket Lane Flowers are $338,000
in its third year of operation. Break-even sales are estimated at $289,000
(estimated cost of goods sold ⫹ expenses for year three).
1. Calculate the margin of safety. Then explain your opinion of this level.
2. Compute as an alternative activity, using spreadsheet software to make
these calculations.

Connect with Economics and Business In economics, demand

for a product usually grows gradually. Unfortunately, a business owner has
to make large investments in lump sums to increase capacity to meet the
growing demand. For example, investment in production facilities is made in
large “jumps” while demand grows gradually.
1. Role-Play Imagine that Electro Toys has experienced great demand for
its products and services, and its owner is thinking about opening two
more stores, a major investment. How can she be sure that demand will
continue to grow and use the additional supply she offers? With a partner,
take on the roles of the shop’s owner and a friend of hers who invested
in her business when she first started it. They are discussing the business
owner’s thoughts about whether to expand.
2. Write About It Write a script about this discussion.

Competition You are considering opening a business providing

home maintenance and “handyman” services. You realize that you will be
competing with large plumbing repair companies and other specialists.
Log On Make a list of services you plan to offer. Then access an
Internet search engine and find sources of such services in your town
to evaluate the competition.
Write About It Write a marketing plan that explains how you will grow
your business by promoting your services so that potential customers can
differentiate you from the competition, and thus, increase your market share.

Newsclip: The Right Price Smart pricing systems are Web-based

systems that adjust prices to changing market conditions.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 22.
Learn about the methods companies use to price goods. Write a list of
some of your favorite things to buy and what they cost.

finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 717

 Chapter 22 Review & Activities

CREATIVE THINKING
Successful businesses rely on a constant stream of ideas and people
with the courage to present them. Do you have a lot of good ideas?
Here is an opportunity to test your creative thinking. Write your
answers on a separate sheet of paper.

1. Do you look for ideas?

Often Sometimes Rarely

2. Do you sometimes play “devil’s advocate” as a way to stimulate others?

Often Sometimes Rarely

3. Do you challenge the rules?

Often Sometimes Rarely

4. Do you ask “what if” questions?

Often Sometimes Rarely

5. Can you motivate yourself and do what it takes to set your ideas in motion?
Often Sometimes Rarely

6. Do you use impractical ideas as stepping stones to new ideas?

Often Sometimes Rarely

7. Do you express silly ideas?

Often Sometimes Rarely

8. Do you challenge assumptions?

Often Sometimes Rarely

Scoring: Give yourself 5 points for each “often,” 3 points for each “sometimes,” and 0
points for each “rarely.”
Beginner: If you scored 0–10 points, consider playing around with new ideas and present-
ing them. Ideas can be fun!
Explorer: If you scored 11–20 points, you are willing to stretch yourself.
Creator: If you scored 21–30 points, your input will be welcome on any team.
Brainstormer: If you scored 31–40 points, you take the lead in risky ideas that may result
in big rewards.

718 Unit 6 Business Finance Basics

 Chapter 22 Review & Activities

Your Financial Portfolio

Business Expansion Magic
Under the name of Morgan the Magnificent, Victor Morgan has been performing magic
since he was eight years old. Now that he is 16, he wants to branch out from school
events and birthday parties for friends and family to perform professionally. He already
has his own Web site and a performance video. To expand the business, he wrote down
the following strategies and actions he could take:

• Make a flyer and a cover
letter I can send out to
potential customers.
• Contact a public relations
agency and offer to do free
performances in exchange
for their helping me get
publicity.
• Call the local newspaper
and ask if someone could
write an article about me.
• Contact the human
resources department of
local companies to let them
know I am available to per-
form at employee functions
and holiday parties.
• Contact local chambers
of commerce to find out
when they are having street
fairs or crafts fairs.
• Contact local stores that
sell or rent party supplies.
Ask if I can post a flyer and
if they can recommend me
if anybody is looking for an
entertainer.
• Contact wedding planners
to see if they would recom-
mend me to be part of the
wedding entertainment.
• Stop by ice cream stores to
find out if I can post a flyer.

Analyze
Pick a business in your town. On a separate sheet of paper, list eight strategies and
actions that could improve or expand the business.

Chapter 22 Pricing, Costing, and Growth 719

 Unit 6
# LAB
Titlea Financial Life!
Get
Growing a Business
Overview
Two years ago, Jack Lanier and his sister
Eva opened their retail store called Party Town.
They sell a wide variety of party decorations,
paper goods, balloons, and games. The business
has been a success so far. Eva and Jack have been
able to meet their expenses each month and
make a modest profit. Now they want to grow
their business. They are interested in carrying a
new line of merchandise and opening an online
store with expanded inventory. With their
regular customers, in addition to new Web-site
customers from outside their area, they hope to
gain a greater share of the market and expand
their business now and in the future.
Resources & Tools
• Crayons, markers, colored pencils
• Internet (optional)
• Portfolio (ring binder or file folder)
• Public or school library
• Resources
Publication software & Tools
(optional)
• Spreadsheet software (optional)
• Word processor
720 Unit 6 Business Finance Basics
Procedures
STEP A The Process
Eva and Jack need help making
a decision about what merchandise they should
carry and the best type of Web site to develop.
1. Recommend a new product or line of mer-
chandise that you think Party Town should
carry. (Examples might include hard-to-find
costumes, piñatas, or party favors.) Create a
flyer, poster, or other visual aid describing
the new product.
2. Research the competition (other party stores,
discount stores, toy stores, and Internet sites),
either by looking through the yellow pages
or by visiting stores nearby. Describe Party
Town’s competition and its merchandise.
3. Interview a business owner of a similar
business in town.
4. Eva and Jack also plan to sell balloon bou-
quets that they will make. The direct mate-
rials will cost $5.25; the direct labor per
bouquet is $6; and the supply costs will be
about $0.85. Assume that Party Town plans
to mark up the bouquets by 80 percent.
Figure out the selling price of each bouquet.
If the fixed costs are $300, determine how
many balloon bouquets Eva and Jack must
sell to break even.
5. Help Eva and Jack set a target profit for the
balloon bouquets. How many bouquets must
they sell to achieve the target profit? Calcu-
late the margin of safety for this product.
6. Research costs of starting a Web site with
e-tail capability, such as costs of Internet
service providers, design, and customer-
service support.
STEP B Create Your Portfolio
As you work through the pro-
cess, save the results so that you can refer,
review, and refine. Create a professional-looking
portfolio of the recommendations that you will
present to Eva and Jack.
1. The first page should be a title page with the
following information centered:
Business Growth
Presented to Eva Lanier and Jack Lanier,
Owners
Party Town
By (Your Name)
2. The first section should include your flyer,
poster, or other visual material describing
the new merchandise and Web site that you
have recommended to Eva and Jack.
3. The second section should present your
research about the competition in your com-
munity and on the Internet.
4. The third section should include the selling
price, break-even point, target profit, and
margin of safety for the balloon bouquets.
Include calculations. Also, include costs for
operating a Web-site.
STEP C The Internet
Almost anything you want to
know can be found on the Internet. It provides a
vast communication network for people around
the world. Students and employees must learn
to use the available information wisely, ethically,
and legally.
1. Write a definition for the term ethics.
2. Many employers have a formal policy that
defines the acceptable and unacceptable uses
of the Internet in the workplace. Write a
policy that Eva and Jack might establish for
their employees.
3. Research one legal issue that can arise
when an employee uses the Internet, such
as plagiarism, viruses, employers accessing
employees’ e-mail, or employees accessing
the Internet for personal use. Write a one- to
two-page paper on the issue.
4. Some people assume that everything appear-
ing on the Internet is factual. However, this
is not always the case. As a class, develop a
list of ways to check the accuracy of infor-
mation that you find.
721